Seven Things to Keep in Mind When Consolidating debt
You are considering a debt consolidation loan. Read on to learn about several key points to be aware of as you initiate the process.
#1: Will Consolidation Affect My Credit Score?
If you have a perfect credit score and plan to be buying a house soon, then debt consolidation may not be for you. The impact of debt consolidation is not large, but your score will drop a little at first. When you consolidate, you’ll just have one positive hit on your report each month, rather than if you were paying off each debt separately on-time. If you begin closing credit card accounts, you will decrease your total available credit, which factors into your credit score; although, it should be noted that you don’t necessarily have to close out your accounts, even though you’re not using them anymore.
Video: Sometimes Your Credit Score Will Improve
Even though these negative hits will occur, you will also be counter-balancing with positive hits when all your debts get paid off. If you decide to consolidate for simplicity’s sake and you plan to pay the full amount, your credit won’t be affected as much. However, if you want to consolidate to get a sweet deal on the interest, it’s reasonable to expect that your credit report will note you “settled.” The good news is that with positive payment history from here on out, your credit score will rebound rather quickly. Remember that3 5% of your score is derived from payment history and that the most recent year or two factors in greater than the distant past.
If you’re the type of person who has been racking up the negative hits on your credit report with missed payments, late payments, going over your credit limit and opening/closing new accounts all the time, then debt consolidation can only be a good thing. Compared to bankruptcy, which will be on your record for 7-10 years, these minor hits will fade in just a few years.
#2: What Will Happen Come Tax Time?
The saying “There’s no free lunch” rings true when it comes tax time for debt consolidation. If any individual creditor agrees to settle with you and offers a savings exceeding $600 of debt, then that creditor must report the amount to the IRS and send you a 1099 tax form. The amount saved is reported to the IRS as a “gift” to you and therefore, you must pay taxes on this. Even so, the amount you’ll pay to the IRS is miniscule: you will still most likely come out with a net savings in the end.
It should also be noted that a good tax professional can possibly get you out of paying by something called the Tax Insolvency Clause, which means you’re your liabilities exceed your assets. You may be eligible to file for a “reduction of tax assets” as well, so be sure to discuss this matter with your tax professional.
#3: Who Are Debt Consolidators?
While they may sound the same, not all debt consolidators are the same. Debt consolidation companies work with you to roll all your high-interest credit cards into one monthly payment at a low interest rate. They will pay off your creditors in full and you will then repay the consolidation company back. Being able to afford this new rate, you’ll quickly be out of debt. This method can get you out of debt the quickest.
Debt management companies assist you in creating a budget, managing your own expenses and helping you to take control of your financial situation. They may give you sample letters and other financial tools to help you negotiate with your creditors on your own. You will rarely get a loan or direct help contacting creditors going down this avenue.
Video: Debt Settlement vs. Bankruptcy
Debt settlement companies negotiate with creditors on your behalf to reduce your balances and negotiate a new, lower monthly payment or lump sum repayment plan. When you pay the settlement company, they’ll disperse your money to the creditors in a timely fashion for you. This can help simplify things and hack away at some of your debt, although the company must be trustworthy.
Not all debt consolidators are good guys, though. Some are unscrupulous fly-by-night organizations looking to make a quick buck off you. To avoid these shady companies, you should check to see that they’re verified with the Better Business Bureau and that they don’t have a number of complaints filed against them. You should also look to see that they’ve been in business for at least five years. Non-profit debt consolidators are always your best bet.
#4: What Are The Fees Involved?
Ideally, you’ll want to find a company that charges one flat fee each month and still saves you money in the end. Some private consolidation companies charge high up-front fees, asking that you make a payment of $1,000 - $3,000 before any of the negotiating is even done. This, they say, will go to making lump sum payments to a few of your creditors to gain leverage. Other companies may charge a $95 “credit analysis” fee; avoid these at all costs! If they want anything more than $50 up front, it’s probably a scam. If a company wants $200 to “clean your credit report,” know that this is another classic scam. You shouldn’t have to wait until you’ve paid the company “40% of your debt” before any payments are made, nor should you be paying $500 or more each month in fees. Before signing off on anything, you may want to read the Federal Trade Organization’s “Credit Repair Organizations Act” to make sure everything is legit.
#5: Will I Pay Lower Interest Rates?
Some people confuse “lower payments” with “lower rates.” Nine times out of ten, a debt consolidation program will, in fact, give you lower interest rates than what your credit cards are charging. If any of your credit cards are above 9%, then you will definitely save with a debt consolidation loan. One thing to consider when consolidating is to aim for having the shortest repayment schedule you can afford. The longer your debt takes to repay, the more interest you’ll be paying.
#6: Will All Creditors Accept Consolidation?
While a good debt consolidation company will smooth things over with all your creditors, some wounds may be too deep and some companies too inexperienced to save you from the quagmire. In some instances, an angry creditor or collections agency may reject the settlement offer and decide to sue you. In all likelihood, they were already proceeding to sue you anyway. If you’ve received a judgment against you and are threatened with wage garnishment, then your debt consolidators should at least be able to refer you to a good attorney and offer to assist you in this matter.
#7: When Is Debt Consolidation Smart?
Before beginning a debt consolidation plan, you need to be honest with yourself. Debt consolidation always looks good on paper: you’re taking high-interest credit cards and slicing them down by more than a third. You’re cutting off excess late fees, interest costs and collection charges. However, you still need to be disciplined enough to save up the monthly payment to repay the debt consolidation loan. If cutting back on your expenses, resisting the temptation to use your credit card, and saving money are major hassles, then debt consolidation may not be for you. By contrast, if you’re responsible and desperately need a fresh start, then debt consolidation can be a lifesaver.
Why Debt Consolidation is Smart
With a legitimate debt consolidation plan, your debts will be paid off right away. Your creditors will stop hounding you and your accounts will be restored to good standing. You’ll be set back on track with a monthly payment that you can afford. Your life will be simplified as you pay this one bill each month, rather than trying to keep track of numerous addresses and due dates. You will say goodbye to 17-30% interest rates that would otherwise make your debts impossible to repay. You’re taking a stand against a sullied past and turning a new leaf. You can now better assess your situation, learn to manage your money better and look at new saving options – without the walls closing in on you.
Debt Consolidation Companies By State:
The Russell Agency
2015 Stonegate Trl, Ste 105, Birmingham, AL 35242